With the help of its banking partner Standard Chartered, Adidas China found the ideal investment vehicle for its excess cash.

Problem…

Regulatory restrictions in China mean that the options for repatriating cash out of the country are limited. adidas China holds a large amount of surplus cash in China which can only be repatriated to the headquarters in the form of dividends. “I can only remit dividends once a year, and that’s generally about six months after the close of the fiscal year,” explains Erick Haskell, CFO of adidas Greater China. “So basically that means you have 18 months’ worth of accumulated profits that you can’t remit.”

The surplus cash used to be invested in time deposits for a fixed period of 30 or more days but the resulting yield was small. “As the business grew and the amount of surplus cash got bigger there was pressure from our headquarters that if we couldn’t remit, we needed to be in search of better yield,” says Haskell.

Initially, Haskell investigated the option of investing the surplus cash into money market funds. However, although the money market funds were far more liquid than time deposits, the yield was not significantly higher. Accordingly, Haskell decided to explore the option of lending funds to other companies using third-party entrustment loans.

…Solved

As direct inter-company lending is prohibited in China, it must be achieved using entrustment loans (also known as entrust or entrusted loans) using a bank as an intermediary. Third-party entrustment loans are a variation of this model, whereby one company with surplus cash can lend that cash to another company. Two banks are involved in this model: the agent bank, which holds the funds and completes the transaction, and the guarantor bank, which guarantees the loan in case the borrowing company defaults. For regulatory reasons the agent and guarantor banks must be two different banks.

adidas has a sizeable long-term relationship with Standard Chartered Bank, both in China and on a global level. “When we decided to seek these sort of yield enhancing opportunities, the natural thing was to turn to Standard Chartered as one of our big banking partners to ask what opportunities were out there,” recalls Haskell. “So we started a discussion about doing third-party entrustment loans and not long after that, Standard Chartered introduced us to our first client.” Although counterparty exposure limits set by adidas’ headquarters require adidas to work with a number of banks, Standard Chartered has continued to play a key role in the project, acting as the agent bank for some loans and as the guarantor bank for others.

The launch of the third-party entrustment loans programme in mid-2007 was well timed. At the end of 2007, concerned that the economy was overheating, the Chinese government restricted bank lending. As a result, demand for third-party entrustment loans dramatically increased.

This also enabled adidas to charge a higher interest rate on its loans. The rate for third-party entrusted loans is agreed bilaterally between the lender and borrower. Whereas initially the rate of interest tended to be halfway between the lender’s deposit rate and the borrower’s cost of borrowing, at the height of the credit crunch adidas was able to charge interest at the same rate as the banks, or even higher. “It was great for me – I was getting a very good yield,” says Haskell. “And it was great for the companies we were lending to, because they were getting access to funds that they couldn’t otherwise obtain.”

Haskell hopes that a relaxation of capital controls in China will one day make it easier to remit surplus cash overseas. In the meantime, the project is likely to expand. “I’ve found that from a risk return standpoint, this is the best vehicle I have for deploying excess cash. Particularly now that we’ve got quite good at it, the administrative burden is low. The third-party entrustment loans have taken up an increasing part of our excess cash and I see this continuing in the future.”